Reality bites for Canada as foreign hunger fades for its securities

TORONTO (Reuters) - Canada is finding it harder to attract the foreign investment in its bonds and stocks that it needs to finance a current account deficit, as yields rise at a faster pace in the United States and structural headwinds stifle prospects for domestic economy.

The moon rises behind the skyline and financial district in Toronto, November 25, 2015. REUTERS/Mark Blinch

Viewed as a safe-haven after the global financial crisis, Canada had seen over the past decade a rapid rise in the purchase of its securities by foreign investors.

But foreign purchases of its securities have slowed to C$29 billion ($22.3 billion) in the first five months of the year due to trade uncertainties and a slowdown in the country’s red-hot housing market. Net inflows in 2017 totaled C$190 billion.

(For a graphic on 'Canada's international transactions in securities' click reut.rs/2LsUx5q)

Canada runs a current account deficit of more than C$60 billion annually so it imports goods and services at a faster pace than incomes are rising. If foreign buying of the country’s bonds and stocks continues to slow then its currency may need to depreciate or its borrowing costs rise to attract the foreign investment that has bolstered consumption in recent years.

“Canada is relying on the kindness of strangers to plug that current account deficit and you can see that the portfolio flows are moving in the wrong direction,” said Mark McCormick, North American head of FX strategy at TD Securities.

“It is a reflection of the cyclical and structural headwinds that the economy is facing. “So, people globally are deciding to park their money elsewhere.”

Headwinds include near record levels of household borrowing and reliance on trade with a more protectionist United States, which has slapped tariffs on steel and aluminum and threatened to impose tariffs on autos. Canada sends about 75 percent of its exports to the United States.

“Trade (uncertainty) has caused a lot of global investors to have concerns about the volatility you will see from Canada,” said Angus Sippe, a multi-asset fund manager at Schroders in New York, who has bet against the Canadian dollar.

The loonie has weakened nearly four percent this year against the greenback, while the gap between Canada’s 10-year yield and its U.S. equivalent has widened by more than 60 basis points since September to a spread of nearly 70 basis points in favor of the United States.

Data from the U.S. Treasury Department shows that foreign buying of U.S. long-term securities has accelerated in the 12 months through May.

“If foreign confidence takes a hit, we are going to have to pay more to attract foreign investors to buy our assets,” said Sal Guatieri, senior economist at BMO Capital Markets in Toronto. “We are going to have to offer higher interest rates or a weaker Canadian dollar with the expectation of appreciation.”

It could become more challenging still to attract foreign investment if the European Central Bank follows the U.S. Federal Reserve and the Bank of Canada and begins raising interest rates.

“All of a sudden, the reasons that you invested in Canada in the first place as a foreigner aren’t as compelling as they used to be,” said Bipan Rai, North America head, FX strategy at CIBC Capital Markets.